Orbital Sciences Management Discusses Q4 2013 Results - Earnings Call Transcript

| About: Orbital ATK, (OA)

Orbital Sciences (ORB) Q4 2013 Earnings Call February 13, 2014 9:00 AM ET

Executives

David W. Thompson - Co-Founder, Chairman, Chief Executive Officer and President

Garrett E. Pierce - Vice Chairman and Chief Financial Officer

Analysts

Patrick J. McCarthy - FBR Capital Markets & Co., Research Division

Howard A. Rubel - Jefferies LLC, Research Division

Tyler Hojo - Sidoti & Company, LLC

Chris Quilty - Raymond James & Associates, Inc., Research Division

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Operator

Good morning, My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Fourth Quarter and Year-end 2013 Financial Results. [Operator Instructions]

I would now like to turn the call over to Mr. David Thompson. Please go ahead, sir.

David W. Thompson

Okay. Thank you, and good morning, everyone. Thank you for joining us to discuss Orbital's fourth quarter and full year 2013 financial results. I'm Dave Thompson, and with me on the phone this morning are Garrett Pierce and Barry Beneski.

Before we get underway, I'd like to ask everyone to take note of the Safe Harbor paragraph at the end of our earnings press release. This paragraph emphasizes the major uncertainties and risk in the forward-looking statements that Garrett and I will make this morning. Please keep these factors in mind as we discuss our future operational outlook and our financial guidance during today's call.

We'll follow our customary outline for the call this morning. I'll begin by discussing some highlights from the fourth quarter and the full year. At that point, I'll ask Garrett to cover our financial results in greater detail and to update our preliminary guidance for 2014 that we discussed with you back in the fall. After that, I'll recap recent space missions and product delivery events and also provide a preview of upcoming operational events that are planned over the next 3 or 4 months. And finally, I'll address new orders and contract backlog, as well as our major new business pursuits that are now underway for the early part of the year. At that time, we'll open up the call for your questions.

So let's begin with some highlights, which I think characterize the company's last quarter of 2013. Garrett and I will cover each of these areas in more depth later in the call. First, though, let's look at our financial performance. Orbital ended the year with a good fourth quarter. Revenues were up 6% to a new quarterly record of $375 million, with strong growth in our launch vehicles and advanced program segments propelling the growth. Operating income was $30.5 million in the quarter, reflecting an 8.1% overall profit margin, and earnings per share increased 22% to $0.28. Free cash flow was $12.7 million in the quarter, and this resulted in a year-end cash balance of $266 million, which was up nearly $35 million compared to a year ago. For the full year, the company's operating income of $113.5 million also set a new record for us and reflected a solid 8.3% operating profit margin. As Garrett will report shortly, our financial outlook for 2014 is strong. We are expecting a revenue increase of over $100 million and a record $120 million to $140 million in free cash flow this year as 2014 begins a multiyear period of robust cash generation after the last several years of heavier-than-normal research and development working capital and equipment investments.

Second, let's turn to some operational highlights. Last year was one of the operationally busiest and most successful years in Orbital's history. The year was rounded out by a strong fourth quarter, during which time the company conducted 4 major space missions, launched 4 smaller research rockets and delivered 4 additional systems for future uses. This brought our full year 2013 total to 21 major space missions and 20 smaller research rocket launches, plus another 12 system deliveries for a total of 53 operational events. This made 2013 the most active year ever for the company's engineering and manufacturing operations, which averaged a significant operational event every week.

We have continued at the same fast pace so far in 2014, with 3 major missions, including our third Antares launch and our second Cygnus flight to the space station, plus a smaller rocket launch and 3 additional deliveries since the 1st of January. Looking ahead, we expect to complete approximately 60 operational events this year, including up to 40 space missions and rocket launches and another 20-or-so system deliveries. I'll have more to say about last year's operational milestones and this year's plans in a few minutes.

Finally, though, here's a summary of new business activity. New contract awards and option exercises totaled approximately $625 million in the fourth quarter. New business in the quarter included new orders and option exercises for 2 satellites, 3 space launch vehicles and 8 target vehicles. Together with previous new business activity in the first 9 months of last year, fourth quarter new awards and option exercises boosted our total new business volume to approximately $2.34 billion for 2013. Firm contract backlog was about $2.15 billion, and total backlog stood at about $5.16 billion at the end of last year, giving us about 85% of our expected 2014 revenue covered by backlog as we started the new year. I'll provide some more details on recent orders and current new business pursuits later on in the call.

Now though, I'd like to ask Garrett to take you through the financial results from the fourth quarter and the full year and to update our preliminary outlook for 2014 that we provided back in October. Garrett?

Garrett E. Pierce

Thank you, Dave, and good morning. Before commenting on the financial results, I want to note that, during this call, we will provide certain non-GAAP financial measures. A reconciliation of these measures to comparable GAAP financial measures can be found in our earnings release or to the extent not addressed there but discussed in this call, will be available as an appendix to the transcript to this call and will be posted under the Investor Relations heading on our website.

As Dave indicated, consolidated revenues for the fourth quarter of 2013 were $375 million, up $20 million or 6% compared to revenues of $355 million in the fourth quarter of 2012, a new quarterly record. The increase in revenues was primarily due to a $21 million increase in the launch vehicle segment that was mainly due to higher intercepter revenues. Advanced space programs segment revenues increased $16 million due to a new advanced flight system program contract award in 2013. Satellites and space systems segment revenues were down $20 million primarily due to lower GEO satellite revenues.

Consolidated operating income was $30.5 million in the fourth quarter of 2013, resulting in an 8.1% operating margin compared to $31.3 million or 8.8% operating margin in the fourth quarter of 2012. Launch vehicle and advanced space program segment results increased by $5.1 million and $5.9 million, respectively, largely due to an increase in the operating margin on the CRS contract from 5% to 5.5%, resulting in a $7 million increase in operating profit. The CRS contract margin was increased after reassessing the contract estimates following an excellent performance of the Antares vehicle and the Cygnus spacecraft on the COTS and CRS-1 missions. Satellites and space system segment operating income decreased $11.8 million, resulting from lower GEO revenues and a reduction in the GEO operating income margin in 2013.

I will now highlight certain factors in each of our 3 operating segments. The launch vehicles segment revenues were $156 million in the fourth quarter of 2013, an increase of $21 million compared to the fourth quarter of 2012. Missile defense interceptor revenues increased $25 million. Space launch vehicle revenues were up $6 million, and target launch vehicle revenues decreased $10 million. Launch vehicles segment operating income was $15 million or 9.6% of revenues, an increase of $5.1 million compared to the fourth quarter of 2012. This was principally due to increased activity on missile defense interceptors and the CRS contract, as well as the increase in the CRS contract margin from 5% to 5.5% that drove a $2.6 million operating profit pickup.

Satellites and space systems segment revenues were $105 million in the fourth quarter of 2013, down $20 million compared to the fourth quarter of 2012. GEO satellite revenues were $55 million, a $21 million reduction, due to the completion of several satellites in late 2012 and early 2013. However, GEO satellites revenues in the fourth quarter were up over 80% from their low point in the second quarter and are expected to increase further in 2014. Satellites and space system segment operating income was $4.3 million or 4.1% of revenues as compared to $16.1 million or 12.8% of revenues in the fourth quarter of 2012. GEO operating income was 4.3% of revenues for the quarter versus 13.6% of revenues in the comparable quarter of 2012. As we have discussed with you in the past, the double-digit GEO margin in the fourth quarter of 2012 was principally due to favorable profit adjustments on contracts that were nearing completion. We expect the GEO profit margins will be in the mid-single-digit percentages for 2014.

Advanced space program segment revenues were $118 million in the fourth quarter of 2013, up $16 million compared to the fourth quarter of 2012 due to activity on a new contract awarded in 2013. Advanced space program segment operating income was $11.2 million or 9.5% of revenues, an increase of $5.9 million compared to the fourth quarter of 2012. This increase was largely attributable to the increase in the contract margin adjustment from 5% to 5.5% that drove a $4.3 million operating pickup.

Consolidated research and development expenses decreased by $20.7 million principally due to the completion of a COTS research and development program, including the related successful test demonstration missions in 2013, in addition to the completion of the Antares development program in 2013.

The GAAP income tax rate for the fourth quarter of 2013 was 26% versus 25% for the fourth quarter of 2012. The fourth quarter of 2013 and 2012 included favorable tax adjustments related to the extraterritorial income exclusions.

Our full year 2013 GAAP effective tax rate was 34% while our full year 2013 cash tax rate was 10%, reflecting the utilization of NOL and tax credit carryforwards.

GAAP EPS in the fourth quarter of 2013 was $0.28 per share compared to 23% -- $0.23, excuse me, for the fourth quarter of 2012. Adjusted EPS for the fourth quarter of 2013 was $0.30. The adjustment reflects the exclusion of a $6.1 million after-tax adjustment to write off an option payment in connection with the business agreement that was terminated in the fourth quarter of 2013 in connection with the conclusion of litigation. On the positive side, we also recognized a $3.7 million net gain on the sale of auction rate securities and a favorable extraterritorial income tax adjustment of $1.1 million. Full year 2013 GAAP EPS were $1.13 versus $1.02 for 2012. Adjusted EPS for 2013 was $1.15 versus $1.08 for 2012. The company's 2013 results reflect lower interest expense resulting from the debt refinancing we completed in the fourth quarter of 2012.

Free cash flow for the fourth quarter of 2013 was $12.9 million, net of capital expenditures of $8.1 million. Free cash flow for the year was positive $17 million, which compares to negative free cash flow of $34.3 million for 2012. Our cash balance increased from the third quarter to $266 million at the end of 2013. In addition, we have an additional $300 million credit facility available.

We expect the 2014 revenues to be in the range of $1,450,000,000 to $1,500,000,000, reflecting a 6% to 9% year-over-year growth rate, and the operating income margin will be in the range of 7.25% to 7.75%. Related EPS is forecasted to be in the range of $1.10 to $1.20. Our GAAP tax rate is forecasted to be in the range of 35% to 37%, and our cash tax rate is expected to be approximately 25%. We are assuming another increase in the CRS program operating margin of at least 50 basis points in the second half of 2014. Due to the timing of expected new contract wins, we also assume that GEO revenues will increase in the mid and latter part of 2014. As a result of these factors, it should be noted that the company's operating results are expected to be notably higher in the second half of 2014 as compared to the first half of the year.

We are forecasting full year 2014 free cash flow to be in the range of $120 million to $140 million. I want to pause to emphasize that the forecast range for 2014 is a significant, a significant turnaround in the cash flow of the company, reflecting the excellent efforts of the company in designing, engineering, manufacturing, carrying out our CRS program and the test work that went before that. This level of free cash flow will set a new company record for annual free cash flow for the company. The principal source of the free cash flow in 2014 is expected to be the monetization of our unbilled CRS receivables as we continue to successfully achieve contract milestones. It should be noted that we expect that certain significant CRS milestones will be achieved in the first half of 2014, resulting in a higher level of positive free cash flow in the first half of 2014 as compared to the second half of 2014. We also expect free cash flow for 2015 should be at similar or higher levels than 2014

Thank you, and now I'll turn it back to Dave.

David W. Thompson

Thank you, Garrett. I'll now update you on the company's major operational events that took place in the fourth quarter and also preview what's ahead in the early part of 2014. As I mentioned previously, Orbital conducted 4 major space missions and also launched 4 smaller research rockets in the final quarter of the year. The major missions consisted of our 25th Minotaur launch vehicle flight in November, which has set a record of deploying a total of 29 satellites into orbit; and the SES-8 commercial satellite deployment in December, which was the sixth commercial satellite that we have built for SES over the last 6 years. We also completed 2 successful missile defense target launches in the month of December. The company also shipped 1 additional commercial satellite to its launch site and delivered 3 missile defense interceptors and target vehicles in the last couple of months of 2013.

Looking back at the full year. The landmark flights of Antares and Cygnus clearly stand out as the most important operational accomplishments of 2013. Our hard work and large investments over the last 5 years were rewarded with 3 picture-perfect launches of the new medium-class Antares rocket from last April through this past month, confirming the vehicle's design integrity, its assembly processes and its operational practices. In fact, Antares conducted its first 3 successful flights in a shorter time interval, just 8.5 months, than any other medium- or large-class rocket has achieved in the past 30 years. The first 2 textbook flights of the Cygnus spacecraft also proved out this product's design and capabilities, conclusively demonstrating the effectiveness of the NASA/Orbital partnership in the COTS program.

In addition to these Antares and Cygnus milestones, Orbital launched, deployed or delivered 50 other rockets and satellites last year. These included 3 small-class space launches, 3 commercial and scientific satellite deployments, 2 missile defense interceptor flights, 10 missile defense target vehicle launches and 20 smaller research rocket operations. Especially noteworthy events in 2013 were: our 45th Pegasus and 25th Minotaur rocket launches; our 30th, 31st and 32nd commercial geosynchronous communication satellite deliveries; and our 40th Coyote supersonic ramjet target flight. The company also launched and commissioned one of the most sophisticated scientific satellites that Orbital has yet built, the LandSat 8 spacecraft, and achieved record-setting 40 consecutive successful research rocket missions for NASA over the last couple of years. As a result of these and other events, we achieved operational milestones in 2013 that only a small handful of other space manufacturers have ever reached, marking 800 space and suborbital missions launched and 1,000 years of cumulative satellite operations time conducted over the past 32 years.

Now looking ahead to 2014. We anticipate that Orbital will carry out 10 to 12 major launch vehicle flights, including 3 Antares launches. We'll deploy and commission 8 or 9 new satellites, including the next 3 Cygnus cargo spacecraft, and we'll launch 18 to 20 smaller research rockets this year. We also plan to complete and deliver 16 to 18 additional launch vehicles and 2 or 3 more satellites for missions that will take place in 2015 and in future periods.

The company is off to a good start with the early January Antares launch and Cygnus flight to the space station for NASA, which executed a flawless rendezvous and berthing to the space station just 2.5 days after it was launched. We also deployed and checked out our first communication satellite of the year for THAICOM, which, last year, ordered another satellite from Orbital. And just a few weeks ago, we shipped to the launch site our second communication satellite of 2014, this one for HISPASAT, it will be launched next month, and which should shortly be followed by another order from this customer. Other first quarter events are planned to include 3 or 4 missile defense interceptor and target vehicle deliveries and several smaller research rocket launches. In the second quarter, we plan to launch our fourth Antares rocket and third Cygnus spacecraft to the space station in early May, to launch or deliver 4 or 5 more interceptor and target vehicles, to ship a NASA scientific satellite in preparation for a June launch and to deliver several other satellites for launches a little later on in the summer.

I'll now take you through fourth quarter new business results and also briefly discuss our outlook in this area for the first half of 2014. As I've noted earlier, fourth quarter new business volume totaled $625 million. This was made up of about $155 million of new orders and $470 million of option exercises under previously awarded contracts. Our launch vehicle segment led the way in the fourth quarter with new business totaling $415 million, with orders and option exercises for 11 space and target launch vehicles comprising that total. It was followed by our advanced space programs unit with $160 million in new business and our space systems segment with $50 million in new business. For the full year, new orders totaled $1.70 billion and option exercises were $640 million, for a total of $2.34 billion of new business activity in 2013. By reporting segment, advanced space programs led the way with $1.09 billion of total new business volume, followed by satellites and space systems with $640 million and launch vehicles with $615 million of new business volume.

Looking ahead to the first half of this year, the company currently has about $1.25 billion worth of proposals outstanding or in preparation that are expected to result in customer purchase decisions by the midyear point. These pursuits involve up to 6 commercial and government satellites, up to 5 space launch vehicles and various new contracts and add-ons in our missile defense programs, national security and scientific satellites and technical services divisions.

In summary, 2013 was one of Orbital's best years in the past decade. Most importantly, last year saw the culmination of the Antares and Cygnus development and flight test programs, both of which produced flawless initial missions and built up strong operational momentum which has continued into 2014. In addition to Antares and Cygnus activities, the company launched, deployed or delivered 50 other rockets and satellites during 2013. We received new orders and option exercises worth over $2.3 billion for a total of 38 major launch vehicles and satellites from 14 customers in the United States and overseas. And we completed the fifth and final year of our major investment program to create a new lineup of medium-class rockets and satellites that should propel good revenue and earnings growth and strong cash flow for the company over the next 3 or 4 years.

Thanks for your attention. We're now ready to open up the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Patrick McCarthy from FBR Capital Markets.

Patrick J. McCarthy - FBR Capital Markets & Co., Research Division

I was wondering if you could walk through maybe the internal process used for determining the margin increase on CRS. And then does that change over time?

David W. Thompson

Yes. Patrick, Garrett and I both made it in. We've attached small rockets to the back of our vehicles and zipped right through. We just skipped overall that electric car stuff. Let me talk a little bit about our approach there, which is really the same one that we use for other long-term fixed-price contracts. We assess, of course, not only the technical performance of the elements of a program like CRS, in this case the Antares rocket and the Cygnus spacecraft, both of which just did a marvelous job in their initial launches last year, but also how our cost in production, assembly and operations is tracking to our estimates. We are always looking at specific items of risk, as well as opportunities on the cost side in comparison to the management reserve that we established in the contract. And from here on out, a good bit of the remaining uncertainty on cost will center on how well we come down the learning curve on -- particularly on labor since most of the subcontracts and materials are pretty well locked in with fixed-priced subcontracts now. So we're pleased with the results obtained. We're optimistic about the future trends. But we want to get through another launch or 2 before we think it will be appropriate to revise the profit accrual rates. Our next mission, CRS-2 operational mission, is coming up in early May. That's only 11-or-so weeks from now. And we'll be prepared for another mission in the early fall, probably late September. So sometime in the second half of the year, I think, would be the right time to reassess CRS margins based on how we're doing with -- really driven, I think, by coming down the learning curve on our own labor over the next 6 to 8 months or so.

Patrick J. McCarthy - FBR Capital Markets & Co., Research Division

Okay. Is it fair to assume that you have 5.5% margins baked into the 2014 guidance though?

David W. Thompson

We think they'll be increased by the time we get to the second half of the year.

Garrett E. Pierce

Yes, a comparable increase. The amount will be comparable to what we recognized this year.

Patrick J. McCarthy - FBR Capital Markets & Co., Research Division

Okay, great. I was wondering if you can give us an update on the study that you're doing on the engines?

David W. Thompson

Maybe I can comment a little bit on that. For competitive and other reasons, I don't want to, right now, get into a lot of details. I can just say that the process of assessing alternatives is well underway. We spent a lot of time on that in the second half of last year. We still have a little ways to go. We should have more to say on that probably by the time of our April call, certainly by midyear.

Patrick J. McCarthy - FBR Capital Markets & Co., Research Division

Okay, great. And then just on the hardware status for Cygnus and Antares, are you -- can you just tell us what numbers of vehicles you're working on at this point?

David W. Thompson

Sure. We've got -- well, let me just start with the upcoming mission on or about 1st of May. All of the hardware for both the launch of the Antares launch vehicle and the Cygnus spacecraft is finished. The hard -- with one minor exception, all of the launch vehicle hardware is at the Wallops Island final assembly location now. The remaining item will come in sometime next month. But it will not pace our final assembly activity between here and there. With regard to the Cygnus spacecraft, the pressurized cargo module for that mission was delivered about 3 weeks ago to Wallops. And the service module, which we build here at our Dallas campus, is finished, and it will ship sometime probably 3 weeks -- 3 to 4 weeks from now down to Wallops. So we're in great shape from the standpoint of hardware for the launch in May. We're also in good shape for the fall launch. Most of the Antares hardware, with a few more exceptions for that launch, is at Wallops. The items that are not at Wallops are completed and will be shipped there over the coming 2 months. The Cygnus hardware, both the cargo module and service module are also at a high state of completion. The cargo module itself is finished and the service module is completing some testing over the next month or 2. So we don't see any hardware-related schedule drivers for either the early May launch or the late September, early October launch this year. Beyond this year, we have quite a bit of hardware that is still either in our factories out -- for the launch vehicle, out in Arizona or for the spacecraft, back here in Virginia or at subcontractor sites. We do have the -- some of the Antares hardware, particularly the first stage structure and tankage, for the 2 launches planned -- or 2 of the 3 launches planned in 2015 already delivered to Wallops. The engine testing is underway this year so that as we finish up, as we come out of the summer, we should have the engines that we need for at least the first 2 of the 3 launches planned for 2015 finished and ready for delivery and hope to finish up the remaining engine testing later this year for the mission at the end of 2015. So we're moving ahead on a pretty broad front of hardware manufacturing for the next 5 missions over the next 24 months.

Operator

Your next question comes from Howard Rubel from Jefferies.

Howard A. Rubel - Jefferies LLC, Research Division

I want to follow on a little bit with Antares and talk a little bit about what kind of customer dialogue you're seeing, David and also, where you're going with NASA in terms of an add-on to the current contract.

David W. Thompson

Okay. Sure, Howard. Let me take the second part of that question first. Our current CRS contract extends through the end of 2016. As I've mentioned before, we have 2 missions -- 2 more missions planned this year in May and late September, early October and then 3 missions next year. And we round out the current contract with 2 missions in 2016. We're getting close to normal lead time for missions in 2017, and so we don't know yet what NASA's exact path forward will be. It's possible that they'll extend the current contract by a year or 2 and 2, 3 or 4 missions to cover their needs in 2017 and '18 and then probably or possibly, at that point, enter into new contracts for missions beyond the period that's about 5 years out. As you probably know, the Obama administration made the decision back in January to extend the U.S. participation in the space station program through 2024, which is, I think, good news for the human space flight program, certainly encouraging for us. And so a new contract may well cover the 6- or 7-year period from either '17 or '18 through that time. But I suspect that the new contract won't be finalized until sometime next year. So we think we have a good shot at an extension for a year or 2 sometime later in 2014. So that's a good opportunity for a handful of additional Antares launches. Beyond that and moving to the first part of your question, we recently submitted our first proposal for a commercial launch for Antares, and we're in -- under evaluation for that now. In addition, we've got, I think, our first opportunity in another U.S. government market area outside of NASA that may come into focus later this year. And as we build experience from the 3 launches to date, 5 launches within the next 7 or 8 months, I think we'll also be well positioned for some potential science satellite opportunities in the 2017-and-beyond period with NASA itself. So we still have some work to do. We have to make a final decision on our long-term propulsion system approach and continue to have these upcoming launches go as well as the last -- as the first 3 have gone. But I think we're feeling fairly optimistic about the midterm outlook for Antares beyond just the next couple of years.

Howard A. Rubel - Jefferies LLC, Research Division

David, if I recall, the original investment case for Antares was kind of 5 to 6 launches a year. So what you might see if you were to put maybe a, I don't know, parameter around it is you're making good progress towards that sort of rate of delivery of launch vehicles into space. Is that -- without putting too many words into your mouth, is that fair?

David W. Thompson

Yes, I think that's fair. You're right, good memory. We had targeted kind of average towards the end of the decade of 5 or 6 launches a year. We're not going to get there in the next 2 years, but I think on that schedule, we ought to have a pretty good shot at 5 or 6 per year by 2018 or 2019.

Howard A. Rubel - Jefferies LLC, Research Division

And then not to give Garrett heart palpitations, but you now have a reasonable amount of cash and a great balance sheet, and this endeavor is behind you, although you're going to be vigilant with it. What's next on your plate to do for expanding the Orbital portfolio?

Garrett E. Pierce

Well, Howard Rubel, it's good to hear your voice. But in any event, yes, we've got, I think, a great challenge to redeploy the cash, and obviously, we will continue to look at organic, inorganic investments. We'll continue to look at cash to be used to buy back our stock. We had a very robust program a few years ago just before we started the CRS program, and we suspended it. So we're through that now. Dividends are still another thing that we certainly consider. We're going to generate significant cash. We can certainly retire debt. So there are a number of options that we have right now that we're considering internally, and that's about all the specificity I can give you right now.

David W. Thompson

What I might just add to that, Howard, is if you look back historically, over the last 10 years, we've deployed, in round terms, about $0.75 billion of excess cash. And we ended up putting about 2/3 of those resources into product and market development between R&D, CapEx and receivable buildup really centered on the Antares and Cygnus programs, and the other 1/3 went to buybacks and some minor -- well, not so minor, but modest-scale M&A activity. Over the next 5 years, we'll probably be in a position to deploy something comparable. In fact, by the end of this year, we should be approaching $400 million in cash, and that will continue to climb absent these deployment options in 2015. So as Garrett said, we'll keep all parts of the triad or maybe it's more than a triad of options open: buybacks, M&A and product development and others.

Operator

Your next question comes from Tyler Hojo from Sidoti.

Tyler Hojo - Sidoti & Company, LLC

Just I guess, firstly, I was hoping that maybe you could break out your guidance by segment.

David W. Thompson

Sure. Tyler, yes, by segment, the outlook for 2014 is roughly as follows. I think the launch vehicles segment will be fairly flat from a revenue standpoint. It was 500 and -- just over $550 million in 2013, and I think plus or minus $5 million, it will probably be at about the same point this year. Operating margins also ought to be fairly comparable to the 8.8% that we achieved in 2013. So that one, if things go as expected, should be close to a carbon copy of last year. The big growth is expected in our satellite and space systems segment. That was about $390 million of revenue last year, and this year we're looking at something north of $500 million, probably in the range of $510 million to $520 million. For the reasons that Garrett indicated, however, the operating margins are going to be down in that segment. They were about 8.8% last year and probably in the mid -- in the 5.5% range this year. Partly, that's the result of just a tough comparison because we did have, both in late 2012 and in the first part of 2013, some contracts that -- commercial satellite contracts that will be finished with better-than-expected late period profits coming through, whereas, for this year, we're ramping up that commercial satellite business again. We don't have the same -- we only really have, beyond what we've done today, only 1 more delivery to go. So the new contracts are going to be accrued at lower profit rates than the older ones were, at least for most of this year. And then for the final segment, advanced space programs, we expect that one to be actually down a little bit. It was about $470 million of revenue last year. At this point, we're looking at probably $415 million to $425 million in revenue. On the positive side, though, we're expecting about 150-basis-point improvement in operating margins on top of the 6.6% that we achieved in 2013 for that segment. So that's the rough segment breakdown. The intercompany elimination term in the equation will also be lower this year. It was in the low $40 million range, I think $43 million or $44 million last year. It should be down around $10 million or $15 million this year.

Tyler Hojo - Sidoti & Company, LLC

Perfect. That's great. And maybe you could just provide us with your thoughts on R&D for 2014. Obviously, it was down quite a bet -- bit year-over-year this quarter. Do you expect that to continue?

David W. Thompson

Yes. In general, we do. Total R&D last year was about -- in round terms, about $90 million, and our outlook for this year is about half of that amount, roughly $45 million of research and development expenditures. We still have a bit of upgrade investments that are underway for tweaking the Antares and Cygnus performance. We are, most of the way, through that work. I think we're about -- coming out of last year, we're 80% or 85% complete, but we'll probably spend about $10 million this year, mostly in the first half of the year, finishing up the upgrades on the Antares launch vehicle and Cygnus spacecraft. Those upgraded configurations will make their debuts on the fall and -- fall 2014 mission for Antares and the winter 2015 -- or '14/'15 mission of Cygnus. In addition, we'll probably spend about $25 million this year in product upgrades and R&D in our GEOStar-2 and 3 commercial satellite platform. We, as you may remember, about 3 years ago, started a product enhancement initiative to extend the reach of the GEOStar-2 product, which is our bread-and-butter commercial satellite platform, from the roughly 5-kilowatt payload power level up to about 7.5 kilowatts. That larger satellite is now referred to as GEOStar-3. And we finished up -- or coming out of last year, we were about 75% complete on that multiyear investment program, but we still have a bit more to go this year. We're also adding something we didn't originally have in the GEOStar-3 program, namely an electric propulsion option. So between finishing up the basic upgrades and adding the electric propulsion work, we'll probably spend about $25 million on the GEOStar line. So the sum of those numbers is $35 million of the $45 million, and the other $10 million will be on a variety of smaller projects.

Tyler Hojo - Sidoti & Company, LLC

Okay. And maybe just lastly, since you talked about the growth in the satellite piece of your business, would you perhaps provide your expectations for orders as we kind of move through 2014?

David W. Thompson

Yes. Sure, Tyler. First of all, just by way of background, it turned out that 2013 was a pretty good year for the commercial satellite manufacturing industry. There were 23 new firm orders placed across the industry. We got 3 of those, plus 1 more option. So we came out of the year with 3 firm and 1 option orders. Our outlook -- and by the way, that was the strongest year since 2009. So it looks like we've come out of the low point of the current cycle. The trough of this cycle was not as low as the trough of the prior cycle. I think it bottomed out in 2011, by my numbers anyway, with 18 orders, so we're up 20%, 25% from the trough. Still not back to the most recent peak year of 2008 and 2009, where we saw about 30 orders, but hopefully, that will come in a year or 2. Our outlook for 2014 is for 4 orders. One of those will be in the form of an option exercise, which has just taken place. So we're off to a good start. One of the -- and then, at present, we have pursuits underway for -- in 5 -- with 5 different customers for what could be a total of 6 satellites. Now those 6 satellites include -- if they all come to fruition as planned, whether we went on or somebody else does, 4 of those 6 are in the -- our traditional GEOStar-2 category, and 2 of them are in the newer GEOStar-3 range. So those will probably be decided in the first half of the year, and then, likely, there'll be a few more opportunities in the second half. So generally speaking, the outlook right now is pretty good in the commercial market, probably better than we've seen it for the last 4, 5 years.

Operator

Your next question comes from Chris Quilty from Raymond James.

Chris Quilty - Raymond James & Associates, Inc., Research Division

So quick question, just, David, if you could give your sort of overall broad thoughts on the NASA budget. Any puts and takes you saw in there?

David W. Thompson

Yes. Sure, Chris. Things worked out, I think, a little better than I would have projected back in the fall. NASA's -- the final budget that came out of the Congressional compromise back in January for fiscal 2014 was approximately $17.6 billion -- or a little bit better than that, $17.65 billion. And that was very close to the going-in request that had been submitted to Congress this time last year, which was $17.7 billion. The areas that are most interest to us are, in the spaceflight area, those accounts that fund the operations of the space station, which include the cargo program, and those came in pretty much right on the requested amounts; and the science programs, which did pretty well, actually did a little bit better than the request, at roughly $5.1 billion of funding, which is a bit higher than we've seen in the last couple of years. So overall, I think NASA fared pretty well. The Missile Defense Agency another government customer that is very important to us also did fairly well, not as -- not by, maybe, historical standards of the late part of the last decade, but ended up coming in pretty much right on the request of $7.7 billion, and the GNP [ph] program, as well as the targets funding, also looked pretty decent. The military space or at least the unclassified military space accounts came in -- were the 1 area that came in below the request, pretty close back to the fiscal '13 actuals, up just a bit compared to fiscal '13 actuals, but down about $700 million or so compared to the request. So final numbers there were about $8.6 billion as we calculate that. So overall, I'd say generally better than expected, and maybe at least for the next year or so, things will be a bit more predictable than they have been over the last couple of years.

Chris Quilty - Raymond James & Associates, Inc., Research Division

Great. With reference to that military space budget, your national security space program has been kind of in decline for a while here. Do you see a trough in that business and potentially an uptick? Or what's your expectation for this year?

David W. Thompson

I don't see an upturn in our business there right away. It will likely be down a little bit in '14 compared to '13. I mean it will still be a couple hundred million in annual revenue. But I think it peaked probably a couple of years back at roughly $250 million or a little better than $250 million, and so I don't see an immediate rebound in that area. Longer term, I'm still fairly optimistic about that business as the military comes to grips with both some new areas of focus -- kind of well-discussed focus on the Pacific, playing to or having -- or being the type of change that would allow space systems to serve to even better advantage and with tighter budgets over time, anyway, the movement towards smaller disaggregated systems that tend to be a little cheaper. But that will take a few years to show up in our business. So in the near term, I see it as being down a bit in 2014.

Chris Quilty - Raymond James & Associates, Inc., Research Division

And a question with regard to M&A. Would you, at any point, consider looking at international expansion? I know you've had some European players or international players, Surrey and MDA, that are establishing beachheads here in the U.S. Does it make sense for you to either start up or acquire something internationally to pursue some of that business?

David W. Thompson

Chris, I wouldn't rule that out on any basic principles. But I also don't think, for us, that it would be as high on the list as good U.S.-based opportunities that might emerge. Of course, those -- whether they're domestic or international, those are kind of episodic, they're hard to predict. We have, in the past year or so, taken a look at 1 specific international situation. We decided not to pursue that in part because of its international peculiarities. But I wouldn't rule that dimension out on first principles. But right now, I don't see -- there's not a lot going on there right now.

Chris Quilty - Raymond James & Associates, Inc., Research Division

And finally, it looks like the ITAR regime is going to be taken down, hopefully, by the end of this year, which -- does that help you in any way in terms of international sales, either satellites, launch vehicles or components?

David W. Thompson

Well, on the satellite side, I don't think it's going to make a big difference. I mean, I think it will be positive, but I think most of the U.S. satellite builders, including Orbital, have learned to operate within the current regime with pretty good results. And so I don't think it's going to make -- it's not going to hurt, that's for sure. But I don't think it's going to make a huge difference in the satellite area. In fact, if you just look at the numbers from last year, the -- let's see if I can recall all of the 23 firm commercial contracts that were awarded. I think you U.S. builders, the 3 major U.S. builders got 15, I think -- 15 or 16 of the 23, certainly, a pretty healthy share. So it won't hurt, but I don't think it's going to be -- going to represent a dramatic change in the competitive landscape. On the launch side, there might be a few things that could be done that were more difficult to do in the past. It's not an area that I've heard much about from our team so far. We haven't been terribly active in the international markets for launch vehicles, although we do have an opportunity we're pursuing now. So I think it wouldn't -- again, the new rules will probably be helpful. It's just a question of how much.

Operator

Your next question comes from Bill Loomis from Stifel.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Just looking at the COTS/CRS Antares program as a total. What was the total revenues following the different proponents in 2013? What do you expect it to be in 2014? And then also, if you could just help us out in terms of how -- the shift from advanced programs and launch, how those numbers will play out in '14 versus '13 on that program.

David W. Thompson

Yes, okay. Sure, Bill. Let's see, these are approximate numbers. For 2013, total CRS revenues were about $330 million, and the allocation between the rocket side in the launch systems group and the spacecraft and mission side in the advanced programs group was about $150 million in the former and about $180 million in the latter. Looking ahead, I think the total revenue this year is going to be pretty similar within probably -- within $10 million, let's say, $320 million to $330 million. So it's going to be very close to last year. The distribution may be a bit different. I would expect the launch vehicle component to be up probably $20 million, so $150 million going to $170 million. And in a corresponding way, the advanced program is going down by $20 million to $25 million, so $180 million dropping to maybe $155 million or something like that.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Okay, great. And then you had mentioned this year's going to be back-end loaded for the reasons you mentioned. Last year's first quarter had very strong margin. The first quarter of this year, I know you're not giving quarterly guidance, but shall we look at kind of like first quarter '12 was being more representative of how it will play out?

Garrett E. Pierce

Well, as we said, Bill, we're looking for performance to increase in the second half. So the first couple of quarters will be -- obviously, we're inferring, is weaker. And I really wouldn't want to go further than that. You'll have to run your models. But we see the revenue and the profitability picking up in the second half for the reasons we covered, the business in general, but more particularly CRS margin adjustment potential and the GEO business.

David W. Thompson

I don't remember the numbers, Bill, and don't have them handy. But what I would point out in regards to last year's first quarter is we still benefited quite a bit, if I recall correctly, at that time from the wrap-up of some of the commercial satellite programs. So you have to kind of normalize that out if you're looking at either the fourth quarter of 2012 or the first quarter of 2013. That's not something we expect to see repeating in this year, certainly not in the early going this year.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And so on the commercial satellites, you'll have 1 older contract that delivers, and I assume if you deliver that successfully, you'll get the higher margin. But that will be it in terms of high-margin benefit in the satellite side and offset by the lower initial margin on your new programs. Is that the right way to think about it?

David W. Thompson

Yes, that's right. We have -- we just have this 1 delivery that -- actually, the physical delivery or physical shipment of the satellites already occurred. Launch is scheduled for next month. And then after that, we don't have another commercial satellite delivery until right about the end of the year or even the early part, the early months of next year. So really, let's call it 1.5 deliveries this year and maybe 3.5 deliveries next year. So I think next year would be the more logical time, if the performance warrants it, for a pickup in commercial satellite margins.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then just finally on the GEOStar-3, what are the other platforms out there, competitor satellite platforms that you see as the biggest competitor? Is that the 702? Or if you could just talk about that and the kind of impact of adding electric propulsion option could give you.

David W. Thompson

Yes. I think most of the major commercial satellite builders have midrange platforms that are pretty well established. Boeing has its 702 series, Loral has its comparable product, as do both of the European builders. Look, several of those companies also have products that are really designed to serve the high end -- or the high-power applications, which we're not pursuing. Our GEOStar-3, although I refer to it as a medium-class or midrange product, really is only designed to cover the lower half of the midrange. Midrange, depending on whose definition you're adopting, can go from 10 to 12 kilowatts, and we're not going up that far. We're going to about 7.5. So we will compete and have competed. We'll continue to compete just in the lower half of the middle power range. I think we have some advantages there in terms of cost and mass and so on. And by -- I think by being able to offer customers an electric propulsion option, we can match or better the mass of other electric propulsion spacecraft. Not all customers are going to be attracted to that, but some will be. And it also depends quite a bit on the pricing and availability of launch services for spacecraft that weigh between, say, roughly 3 and 4 metric tons at launch. So it's an area where we want to be able to effectively compete for those customers that, when they put all that together, do see a real benefit to electric propulsion systems.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Do you -- I mean, does this meaningfully expand market opportunity for you over the next couple of years with the GEOStar-3?

David W. Thompson

Yes, it does. I mean, historically, we've had -- we focused on the small market up to about 5 kilowatts of payload power, and that market, over the last 5 years, has averaged about 5 to 6 orders per year. I think the best year it ever had was 2009, when there were 7 orders in that class, and we got 4 of them. And at least in recent times, the slowest year it had was 2012, when there were 4 orders, and we got 2 of those. So we've been pretty consistently winning about 50% of that market by expanding to the GEOStar-3. I would expect that the total addressable market for us will roughly double in terms of numbers of satellites. The value per satellite will be higher, but our most likely share in that larger market may not be quite as high because there are -- there is a higher level of competitive intensity even in the lower half of the high power market. But I think for us, incrementally, as we better establish the GEOStar-3 product, it could mean 1 or 2 orders each year at a higher average revenue per unit than we have today. So incrementally, 1 or 2 on top of what has averaged about 4 -- 3 or 4 per year over the last 5 years.

Operator

Your next question comes from Michael Ciarmoli of KeyBanc.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Just 2 quick ones, maybe. First, on the satellite margins for 2014, the 5.5%, can you just give us a sense, is there anything structurally changing in that business? I mean the last time you guys had margins that low on a full year basis was '05. I mean, are the -- is the contracting environment getting tougher? Is there more overhead involved? Or is it just simply conservatism on your part?

David W. Thompson

Mike, I think there's a couple of things that are happening. You mentioned one of them. I think the pricing environment is tougher or at least that's the impression I have from the experience of the past year or so. I think the pricing environment is a little tougher than it has been for a while. We're also -- on one of our newly awarded contracts, we are -- it is the first of the GEOStar-3s. And so having never built -- we've developed it now. But having never built one before, we're probably a little more cautious on that. And in order to establish the product, when it's the new kid on the block, it's not going to command perhaps quite the same price that more established product will command. So for those reasons, I think pricing has been a little tighter. And this year, unlike -- I don't know if I can go all the way back as far as you did, but unlike the last 3 or 4 years, we have an unusual mix of new contracts starting up with older -- with very few, really 1, older contract being completed. So that also factors in. Those are the 2 big ones. Not that -- I would say there's not really much else that's different of any significance from the past 3 or 4 years.

Michael F. Ciarmoli - KeyBanc Capital Markets Inc., Research Division

Okay. Okay, that's helpful. And then just the last one that I had. You mentioned, in advanced space, a new contract driving some growth there. I'll assume that's STRATA launch. And if you can maybe just comment on sort of the expectations for that program. Seems like it could be a nice opportunity for you guys.

David W. Thompson

Yes. Well, let's see. I don't want to say a whole lot about that. It's proprietary to the STRATA launch itself. It is expected to be a growth area for us in 2014 compared to '13. The program itself is really exciting. It's progressing well. We've got long line of engineers that would love to get signed to it. We've got a pretty sizable group already assigned to it. Our near-term focus is on completing the preliminary design of the system, which will be reviewed next month. It seems to have converged pretty well over the last almost a year, I guess, since we really ramped that program up. Looking ahead here, about 2 years, aircraft testing of the carrier platform that is being built by scaled composites is planned in 2016, and launch vehicle test, both ground test and flight test, will start a year or so after that. So it's still a little bit out in the future, but so far so good. And it will be a good contributor to our business more significantly in 2014 and beyond than it was last year.

Thanks to you, too, Mike, and to everyone that joined us this morning. I think we'll bring the discussion to a close at this point. We look forward to talking with all of you soon. Thank you, and good morning.

Operator

This concludes today's conference call. You may now disconnect.

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